An alternative perspective

14 August 2015

What’s Next for Europe?

After yet more all-night European summits in the early summer, and another bailout, Greece is still in the Eurozone – just. But at a price. Greece is now effectively in administration. The creditors have taken control. No one really thinks Greece can pay back what it owes, and no one expects it to become a modern market economy any time soon. It is on a life support system, paid for by Germany and other Eurozone countries, and will remain so through many summits and renegotiation crises to come.

The reason Greece still has the euro is much more to do with the politics of European integration, and the stability of the Eurozone as a whole. Having been written off so many times as a deeply flawed currency union, which will inevitably fall apart, the latest round of the endless Greek tragedy has broadened the scepticism. The fact that France took the debtors’ side against Germany merely helped to emphasise how disunited the Eurozone has become.

Yet all is not doom and gloom. There is another scenario, which sees the Greek episode as a right-of-passage and a signpost towards further integration. The fact is that Greece has not been able to get away with breaking all the rules. Greece has been desperate to stay in the euro, even to the extent that it agreed a raft of measures that its electorate rejected in a debtors’ referendum.

The Real Greek Problem - Not Enough Reform

The Greek problem is not the euro. On the contrary, the euro has merely forced Greece to recognise that its economy is riddled with corruption and clientelism, and its public sector is unfit for purpose. The Greek economy is in a mess because the Greek economy is sclerotic. The list of reforms now forced upon it includes many it should have chosen for itself, had its political system been working properly. Opening up markets, addressing its bloated welfare state, getting the core assets out of the hands of the state and into those of accountable private companies, opening up its labour market – these will all help Greece to greater competitiveness. To these positives, the crude idea that it can borrow without any obligation to pay back its debt, and that it can fudge its statistics, are now revealed for what they are – dangerous populist delusions. No currency union can proceed on this basis. No wonder that the other Eurozone leaders have lost trust in the Greek government.

As for the rest of Europe and the Eurozone, things are looking up. Economic growth is on the up across the board. Ireland and Spain have bounced back, Germany is growing strongly, and even Italy has positive growth. Many of these countries look in better shape than they did in the pre-Eurozone days. Low levels of growth in Europe are not a post- Eurozone phenomena. Indeed EU countries outside the Eurozone have not done much better, and several have done worse.

Reasons to be Cheerful

The conventional wisdom is that Europe is economically doomed. It is argued: that the rise of China and the East Asian countries present an existential threat to Europe’s economic model; that the US has great cost advantages, notably in energy; that to compete Europe will need much more flexible labour markets; and that it can no longer afford generous welfare states. Put more directly, Europeans are living beyond their means, and their standards of living have to fall to match the cheaper Chinese labour costs and bridge the gap of their lower productivity levels relative to those of the US.

Parts of this conventional wisdom have some merit, but its underlying assumption is that future competition will be about labour costs and, in particular, global labour costs. At one level it is vacuous: there has always been cheaper labour somewhere in the world. Cheap, poor workers are not a new phenomenon. What is new, however, is the ability of countries like China to access all markets, and for labour to migrate at scale – in China’s case from the countryside to the cities, and globally into Europe, the US and other economically attractive destinations.

This begs two questions: is competition in the future going to be all about cheap labour? And: is the further globalisation of markets inevitable? The first of these is the one that matters the most. The direction of travel for manufacturing and services is one in which technological progress is transforming the deep structure of economies. Increasingly it is human capital – knowledge, ideas and entrepreneurship – which drives successful businesses. New technologies will reinforce this. Robots cost the same wherever they are deployed – and they are often much better than cheap labour. 3D printing transforms the manufacturing process – from mass production lines and huge factories, to bespoke decentralised production, close to the point of consumption. Then there are new materials like graphene, capable of revolutionising a large number of processes. There are also the new genetics and the biotechnologies.

Does China (and the East Asian countries) have competitive advantages in this world? It has lots of educated people, but not necessarily the sort that thrive in this new environment. And China has lots of disadvantages, once the labour costs are taken out of the equation. It does not have an open society, credible property rights and a functioning democracy. Instead it has an authoritarian regime, rigged financial markets and property rights that depend upon the whim of the Communist leadership. Its environment is heavily polluted and its pyramid of corporate debt is enormous. This is not a recipe for further success.

The second necessary condition for China’s rise – globalisation – is taken for granted, but it is rarely noticed how much this depends on the nature of the production processes. The reason why so much has been outsourced to large factories in China is because it is standardised and suitable for production-line manufacture. This is changing. Ever increasing trade is not inevitable. Outsourcing production is a function of cost differentials, not an economic law.

When history is written, it may well turn out that China got lucky: that the particular alignment of the stars uniquely favoured its development in the last three decades. It is largely pre-shale oil and gas, and hence before the cost competitiveness in energy that the US now has. It coincided with the great consumerdriven boom of the late twentieth century. It is not obvious that its luck will last much longer.

Europe's Achilles Heel

The prospects for Europe in the new world are much better than they are often portrayed, but it is not inevitable that Europeans will grasp the opportunities in front of them. The welfare state issue remains: Europe dominates global welfare spending, commits its working population to high taxes to pay for a growing army of the old, and provides benefits rather than work for too many.

Nowhere is this more apparent than in the sick man of Europe – France. Whilst everyone else in Europe has taken the great recession as an opportunity to force through change, France has not. But for the euro even less would have happened, and France would no doubt have run even bigger deficits. Balancing its budget is almost unknown in France – on current projections it will clock up nearly half a century of continuous deficits by the end of this decade.

France’s markets have Greek characteristics too. Indeed some aspects are even worse. The 35-hour week is one example, but France too protects its small shopkeepers, its farmers and its public sector workers. It is small wonder that France took the debtors’ side in the recent Greek negotiations – against its long-time partner, Germany.

The German Model

Europeans rail against Germany and the German model – order, commitment, balanced budgets, export orientated, high technology and its extraordinary Mittelstand companies. But what is not to like? Do Peugeot and Renault stand comparison against BMW and Volkswagen? Where are the French Mittelstand companies? What indeed does France have to offer the future, compared with Germany? Will France be quicker off the mark with 3D printing, robotics and new materials? Does France have a serious technical university system?

It is true that the euro has served Germany well. It has kept the exchange rate down. But why has a lower exchange rate not benefited France? It is not hard to think of the answer. Remember too that Germany’s economic miracle in the post Second World War years was in the context of an ever rising exchange rate. Faced with a hard constraint, the Germans innovated, forcing through technological change. This is a country that absorbed the economic basket case of East Germany, and still emerged on top.

Europe is the biggest single market in the world – at least in theory. It has a great deal going for it, and the stars are better aligned in terms of the future nature of production. It has great depth in its education systems, and it has an open society. The great recession and the Eurozone crises have forced it to readdress its welfare states. It could grasp these opportunities, and Greece could be a turning point, more of historical interest than an existential threat. Or it could not: the rise of populism, the resistance to change in countries like France and Greece, could leave it in the pit lane. There is at least a choice; nothing is inevitable about a European decline.

Dieter Helm is an economist, specialising in utilities, infrastructure, regulation and the environment, and concentrates on the energy, water and transport sectors in Britain and Europe

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